Speech
Opening Statement to House of Representatives Committee on Economics, Finance and
Public Administration

I would like to start by endorsing the remarks of the Chairman and saying what a
pleasure it is to be in Wagga Wagga for the first hearing to be conducted outside
Sydney, Melbourne or Canberra. Like you, Mr Chairman, I think it sets
a good precedent for future meetings, even if it does represent a cautious
start, given that Wagga Wagga is half-way between Melbourne and Sydney and
not that far from Canberra. Perhaps the Committee will be more adventurous
in its future choices. I would also like to record our thanks to the Mayor
of Wagga Wagga and his colleagues and to Kay Hull (a member of this Committee)
for their hospitality earlier this morning.

As usual, I would like to start by reviewing the forecasts I put before the Committee
at the previous meeting in Melbourne in May. Starting with
economic growth, you may recall that the Australian economy grew by
about 4½ per cent per annum in 1997, 1998 and 1999, and, as usual, we
were expecting a modest slowdown in the year to June 2000. The forecast I put
forward for that period was 4 per cent, and the outcome was 4.7 per cent, continuing
our tradition of modest underestimates of economic growth.

For the year to June 2001, I said that we had no quibble with the figure of 3¾
per cent contained in the Budget Papers, nor would we quibble with the recent
update which puts it at about 4 per cent. It is largely a matter of rounding,
and not much should be made of small differences: the figure is meant to suggest
again some modest slowing from past growth rates. I would note that the number
for GDP growth involves a substantial slowdown in final domestic demand –
from about 6 per cent growth to about 3 per cent – which is mostly offset
by a further swing in net exports into positive territory and the assumption
that the inventory rundown recorded over the past year does not occur again.

On inflation, the story is a little more complicated. Last time we met,
I said I expected the CPI to rise by 3 per cent in the year to June 2000 –
the actual outcome was 3.2 per cent. Not a very big difference, but the first
time for quite a while that the outcome was higher than forecast. The reason
for this was the higher-than-expected oil prices. When we look ahead, we should
make sure our forecast goes beyond June 2001 in order to avoid the ‘once-off’
lift to the price level attributable to the GST. At the last hearing, I suggested
that inflation could be in the upper half of the 2 to 3 per cent range once
we are well into 2001/2002. Our Statement on Monetary Policy, which
was released about two weeks ago, forecasts that inflation would be around
3 per cent by that time. This small increase is primarily due to the lower
exchange rate now prevailing compared with the middle of the year.

You are probably tired of being reminded that we are still in the longest expansion
we have had for three decades, but that fact has to be the starting point for
any economic discussion. When we receive the September quarter national accounts
in a couple of weeks time, I expect to see them confirm that the expansion
has continued unabated into its tenth year. During this period, the growth
rate has averaged 4.2 per cent per annum, and most of the annual rates have
been between 3 per cent and 5 per cent, with a few outliers above and below
this. Over the whole period, inflation has remained low, which, of course,
has been a major factor behind the expansion's longevity. And, in turn,
this has contributed to a fall in the unemployment rate of nearly 5 percentage
points to 6.3 per cent.

Despite this record, we should not become complacent – we should always be
looking ahead to see where the risks to the outlook are likely to come from.
Not surprisingly for an economy like ours, which is in reasonable balance,
the risks are on both sides. That is, while we are comfortable with our present
forecast, there are circumstances which could lead to a stronger economy and
hence a speed-up in inflation, and others that could lead to a greater slowdown
in economic activity than our current numbers indicate.

I will start with the risks to the inflation outlook. Obviously, the current year
has not been an easy one in this respect. In addition to the GST-induced lift
in the price level - which was easily foreseeable and appears to have gone
according to plan or better – we have experienced two upward ‘shocks’
in the form of the rise in oil prices and the fall in the exchange rate. It
is never easy to digest three such events in one year, so we have to be especially
vigilant to make sure that any rise in prices is ‘once-off’, and
on-going inflation does not rise to the point where it threatens our medium-term
objectives. So far, we seem to be on track to pass this test. The GST caused
a smaller rise in the September quarter CPI than expected and, on balance,
the data on wages suggest that wages are growing in a way consistent with our
inflation target. But there is still some way to go before we can be confident
that these temporary factors do not push us off course. If it turned out that
the economy was more buoyant than we think, the chances of the shocks feeding
into higher on-going inflation would rise.

I will now talk about risks that the outlook for economic activity could be weaker
than we currently envisage. But before doing so, I should remind you that our
forecasts already embody a slowing in GDP growth compared with last year, and
a more pronounced slowing in domestic demand. So we are not oblivious to the
presence of some factors which point to a less buoyant outlook than we have
had over recent years.

The first of these risks is the world economy, and the United States in particular.
For some time now, most observers have expected lower growth in 2001 than in
2000 for both the world economy and the United States, but there is always
the risk that the turnaround could be sharper, particularly if there is a shake-out
in asset prices. No-one can be sure that, after such a long expansion, the
United States can achieve a soft landing, but at present the odds point to
this result.

On the domestic front, the area of weakness that many people point to is in housing
construction. There is no doubt that there will be a big contraction here,
but we should remember that it was predictable (and has been predicted by virtually
all forecasters for some time). We have just gone through a period when activity
in the housing sector was really quite frenzied. At its peak in the June quarter,
investment in dwellings was at its highest level ever as a percentage of GDP.
A lot of activity in the housing sector that would normally have taken place
this financial year was brought forward into last financial year in order to
get in before the GST, so the cycle in housing is likely to be more pronounced
than normal. The rises in interest rates, no doubt, also played a role, but
they were small compared to the GST effect.

The third risk that some people have focussed on is business confidence. We have
to be careful here because we have over a dozen surveys of business confidence
and they do not all show the same results. Even so, it is true to say that
business confidence is not as high as it was a year ago and that it has fallen
in recent months. I think the recent fall owes a lot to the realisation that
the housing and construction sector will be weak, to the fact that a number
of businesses have only recently had to face up to the practical implementation
of paying the GST, and to rising petrol prices.

What does the foregoing mean for the economy and for monetary policy? Starting with
monetary policy, our main message is that it will continue to be conducted
according to the medium-term principles contained in our inflation targeting
approach. We think this approach has served the economy extremely well, not
only in the direct sense that it has maintained low inflation, but in the wider
sense that it has provided the preconditions for sustainable growth. We will
be looking closely at all the influences on inflation over the coming year
– including the demand pressures in the economy, the growth of wages,
and the level of the exchange rate – in order to judge how they will
collectively influence the outlook. Monetary policy will then be set accordingly.

We will also, of course, be closely watching developments in the real economy, the
labour market, financial markets and our exports and imports. There is a wide
range of statistics available on an almost daily basis, from the Bureau of
Statistics and from other sources, which chart the course of these economic
variables. You only have to read the daily press to see how much attention
is paid to these statistics. We at the Reserve Bank, of course, follow them
in great detail, something we are able to do because we have a good staff and
a lot of experience at examining them. But I want to suggest to you that this
sort of data gazing, important though it is, is only one aspect of assessing
likely developments in the economy and, on its own, can at times give misleading
signals. The problem with statistics is that, as well as containing systematic
information, they also contain a fair bit of random variation and sampling
error. Sometimes this means that we get a group of strong statistics arriving
together or a group of weak ones, which may signify nothing more than the statistical
anomalies referred to above. If we rely only on these statistics to form our
view of the outlook, we run the risk of regularly swinging from optimism to
pessimism and back again, depending on relatively short-term variation in the
data.

Obviously, other approaches are needed to augment exclusive reliance on statistical
observation and so help to identify the underlying direction of the economy.
There are many advocates of approaches such as sophisticated econometric modelling,
extensive industry liaison, and examination of leading and lagging indicators
or the forecasts embodied in financial prices. All of these have their merits
and can provide a broader perspective. But there are two other approaches that
I would like to remind you of.

The first is to go back and examine previous expansions and ask what were the imbalances
that brought about their demise, and then to see whether those imbalances exist
at present. I did this earlier this year in a speech in Melbourne,[1]
where I identified a number of domestic imbalances in previous cycles: high
inflation, a wage surge, overvalued asset prices, excessive physical investment
and excessive credit growth. Not all of these were present towards the end
of earlier expansions, but usually two or more were.

In looking at the Australian economy at present, it is hard to see evidence of any
of these imbalances.

Underlying inflation is about 2¼ per cent, rising to 3 per cent over the forecast
horizon.

Wages are growing at somewhere between 3 and 4 per cent.

The share market has risen over the year, but does not seem overvalued compared with
many overseas markets. House prices have risen over recent years, but appear
to be stabilising at present; rises in commercial property prices have been
quite restrained.

There has been no evidence of over-investment or over-capacity in plant and equipment
or construction.

Credit to households is still growing strongly, but appears to be moderating. Credit
growth to businesses has not been unduly strong at any stage in recent years.

Overall, I think it is hard to find signs of the type of imbalances that occurred
in the early 1970s, late 1970s/early 1980s and late 1980s which led to such
unhappy results. Many people would add the current account of the balance of
payments to my list, and point out that in the later stages of previous expansions,
fast economic growth led to a widening in the current account deficit. Again,
we are different this time in that the buoyant domestic demand growth we have
experienced over the past year has been accompanied by a decline in the current
account deficit.

Of course, I have only listed domestic factors that give rise to imbalances and imperil
the expansion. As I said earlier in my introduction, the world economy plays
an equally important role, but we have no control, or even influence, over
that. It is possible to construct disaster scenarios for the world economy,
and no doubt some will, but I am comfortable sticking with the majority in
assuming a modest slowdown in world growth or, in current parlance, a soft
landing.

No two economic expansions are the same; each of the previous ones differed, and
the present one has its own unique features. As a result, we cannot rely only
on cyclical comparisons such as I have just presented, but they are a helpful
part of any overall assessment. A second approach, which I think is a useful
reality check, is to look at how the present setting of policies is affecting
the economy.

On monetary policy, there is a tendency for attention to be focussed on changes in
interest rates, even when each change is quite small. It is at least as important
to look at the level of interest rates in nominal and real terms, and ask whether
their present setting involves a significant risk that the economy will overheat
or contract. As you know, a year ago we thought that the continuation of the
then setting of interest rates would risk the former outcome. That is why we
moved to our present setting, which we would characterise as being in the neutral
zone, i.e. not presenting either of the two risks to any substantial extent.
Because it is in this zone, there is no overwhelming case to move it in a particular
direction at present. Overall, the main point for present purposes is that
you could not claim that the current setting of interest rates is inhibiting
the growth of the economy.

Another important influence on the economy which is often put under the heading of
monetary policy is the level of the exchange rate. I do not wish to spend much time on this
subject today because I devoted a whole speech to it less than a month ago.[2]
Suffice to say that I do not think there is anyone who would deny that the current
level of the Australian dollar makes our exporting and import-competing industries
super-competitive, and hence it is exerting an expansionary influence on the
economy.

On fiscal policy, the need to more than compensate consumers for the imposition of
the GST ensured that it moved in an expansionary direction between last financial
year and the present one. Again, I think we can all agree that, even though
the budgetary position will remain in surplus for medium-term purposes, the
current stance of fiscal policy is not imposing a contractionary influence
on the economy.

Overall, therefore, I conclude that because the economy has not developed the imbalances
of the past, it has not been necessary to attempt to remedy them with the sort
of counter measures in the fiscal and monetary areas that were often needed
in the past. This is another way of saying that we have, in my opinion, avoided
the boom-bust cycle in economic policy, and hence have an excellent outlook
for the coming year.

I have no further comments to make on the economy at this stage, but will be happy
to answer your questions. The only other point I would like to make concerns
the economics of banking. In the past, we have often provided to the Committee
a paper on some banking subject, such as bank margins or bank fees and charges.
On this occasion, there is no special paper, but we have recently finished
a major study, in conjunction with the ACCC, on interchange fees in credit
and debit card schemes. We will be happy to answer any questions on that study.